The Value of a Trading Plan
March 14th, 2010
One common mistake that traders make is not following trading systems. Without an excellent system on paper, you are far more likely to trade based on guesses and hunches. Some traders feel that there is nothing wrong with this. Making trades based entirely on gut feeling however puts trading at the same level as games of luck. This is like saying that your success depends entirely on the whim of fate.
Bad things can happen when you don’t have a set plan. Other than putting your fate in the hands of luck, the absence of a plan can also make emotional trading far more likely. It becomes easier for you to trade on what is popular simply because you don’t want to be left out. Emotional trading is also marked by holding on or letting go of a trade when you shouldn’t just because you are afraid of suffering losses.
Which stock trading system is best? The best system is one that can make you enter and exit trades based solely on logic. Before you can succeed with any plan however, you need to make the personal commitment to stick to your system regardless of how things turn out or regardless of whether you start winning or losing.
It’s fairly easy to decide to make a commitment to a strategy. Before you do however, you have to make sure that your plan will work. Knowing that it does work will increase your confidence in it and will thus confirm the advisability of committing to it.
The only way to test how well your strategy will function is through back testing. This is the method of testing your trading plan against a set of past trading data. In other words, this is a way of seeing how a system would have performed if it were used on past trades identified using your predetermined criteria.
You can manually back test your system. This however will most surely be a labor intensive task. Moreover, it might be a particularly difficult choice because you may not always have access to the necessary data for testing. An alternative to manual testing is to use a software tool. There are a couple of tools available online that you may want to try. Some of these offer their own sets of data. It is often better however to settle for programs that are compatible with third party data providers so you can choose those that provide the kind of data that are specifically important for you.
Back testing is only one trading tip that you should take note of. Aside from making sure you test your system, you also need to focus on building a plan that is custom made for you. You might be able to work with some aspects of a popular system. Remember though that successful systems used by other traders were made with different goals and risk management terms in mind. Make sure that the plan that you follow matches your personal goals and the level of risk that you are willing to take.
There will always be people who will try to convince you that there is such a thing as a best trading system. The best plan however is really that which is made just for you.
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